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ECB’s Wellink: We must be very careful on inflation

Forecasts suggest euro zone inflation will fall back to around 2% at the end of the year or early 2009, but the price outlook is hard to gauge right now, ECB Governing Council member Nout Wellink told Reuters.

In an interview, Wellink said it was very hard to assess how commodity prices, which have been rising but which might fall as economic growth slows, could impact the outlook. “From the forecasts I know, according to these forecasts, inflation will come back to let me say around 2% only at the end of the year, the beginning of next year,” said Wellink, the Dutch member of the European Central Bank’s rate-setting council. “But these are forecasts. I find it extremely difficult in present circumstances to be precise on this because inflation is determined to a great extent by what is happening in commodity markets, where there is quite a lot of speculation as you know.” Annual consumer price inflation in the 15-country euro zone hit a record high of 3.5% year-on-year in March, up from 3.3% in February and well above the ECB’s medium-term target of close to but below 2%.

The ECB has held rates steady for 10 straight months as concerns on inflation have overshadowed worries financial market turbulence could exact a big economic toll. On Thursday, after a decision to keep rates at 4%, ECB President Jean-Claude Trichet said: “Financial market turbulence ... could have a broader than currently expected impact on the real economy.” Wellink said economic slowdowns in the past tended to reduce commodity prices, but it was not easy to say how long that might take or if it would happen this time around. “So we have to monitor the situation very closely. We will have to see whether a weakening of the world economy will have downward pressure on prices. We don’t know to what extent it will be the case. On the other hand, we don’t know to what extent this dynamic with respect to food prices, oil prices and other commodity prices will continue.”

The ECB cannot influence food prices per se, but it does labor to make sure commodity price rises do not generate other price increases, or so-called second-round effects. Asked if he saw such second-round effects, Wellink said: “To some extent but not in a generalized way, not yet linked to food prices but linked to previous favorable developments in our countries” within the euro area. “For example, you see in Germany that people are fed up with wage moderation, and to some extent I understand that ... this is a second-round effect. It’s not abnormal at the end of the cycle,” said Wellink. “But now what you’re seeing is that inflation runs up rather quickly and I think the most important thing at the moment is to prevent that increase in inflation from coming back and resulting in higher prices,” he said. “We haven’t seen it yet but I think we should be very careful.”

Wellink said the outlook for growth was also very hard to gauge in a precise manner but that he judged the latest forecasts from the International Monetary Fund as realistic when taken for this year and next year together. The IMF is forecasting 1.4% GDP growth this year in the euro area and 1.2% next year. Many other finance officials from Europe have said the 2008 forecast is unduly pessimistic. “The US economy is slowing and under normal circumstances this results, with a certain time lag, in a negative impact on growth in the rest of the world and in Europe. But the precise time lag we do not know,” said Wellink. “So my feeling is don’t focus too much on one year and take into account that the lags are uncertain and the dynamics are uncertain,” he added. “I am inclined to combine these two years and the forecast of the IMF for the two years as a whole do not seem unrealistic to me.” (Reuters)